Inheritance tax - beyond reform?

Inheritance tax raises strong emotions, not least because “it affects people only occasionally, in sometimes significant and surprising ways, and at a sensitive time”.

That observation, made by the Office of Tax Simplification’s tax director Bill Dodwell and chair Kathryn Cearns in a July 2019 report, will strike a chord with many executors and inheritance tax (IHT) practitioners.

The OTS is examining the “design complexities” around IHT and makes 11 recommendations for a more coherent and understandable structure. It believes its proposals could streamline gift exemptions, make tax on lifetime gifts simpler and more intuitive, and improve both business property relief and agricultural property relief.

This article focuses on three key areas.

Lifetime gifts The OTS suggests an overhaul of the complex array of gifts exemptions. It proposes replacing the £3k annual gifts exemption and the exemptions for gifts on marriage or civil partnership with a personal gifts allowance.

The government should consider the level of that new allowance and the level of the £250 small gifts exemption, the OTS says, adding that the “normal expenditure out of income” exemption could be either reformed or replaced with a higher personal gifts allowance.

Lynne Rowland, partner at Kingston Smith, believes IHT can be simplified but says “the most obvious way is to abolish it”. The OTS recommendations on gifting do not go that far, but “there are some other voices proposing the measure”, she adds.

The OTS’s proposed package is not a simplification, she argues, because it merely updates and replaces current reliefs and exemptions: “It is a modification, and a missed opportunity. There is hope that, when any of these measures are debated, the government of the day will be brave and more radical in its approach,” she says. One option would be to set a high lifetime limit and simplify record keeping, “maybe keeping a running total and declaring it as part of the annual self-assessment return”.

That would help executors dealing with probate, and encourage taxpayers to consider and record gifts made on a more real-time basis, Rowland adds. The seven-year period during which a lifetime gift may become chargeable requires a lot of record-keeping but raises little tax, and should be reduced to five years, the OTS says.

The taper relief for gifts made more than three years before death is widely misunderstood and should be abolished, and the rules on liability for tax on lifetime gifts should be simplified, it suggests. 

Interaction with capital gains tax

Next, the OTS suggests removing the capital gains tax ‘uplift’ on death where an IHT relief applies.

There would be a deemed no gain, no loss disposal for capital gains tax (CGT) on the death, but the person inheriting the asset would be treated as acquiring it for CGT purposes at the deceased’s own base cost.

Mishcon de Reya partner Andrew Goldstone notes the OTS’s argument that the current system allows for avoidance of both CGT and IHT on death – due to the spouse exemption or 100% business or agricultural property relief – and discourages lifetime giving.

“That may well be true but [the proposed ‘no gain, no loss’ transfer on death] is nothing to do with tax simplification and all to do with policy,” he says. “If implemented, not only would the tax take increase but the system would be far more complicated as it would have to deal with all sorts of anomalies and rely on historic records of the deceased’s acquisition cost.”

Kevin Offer, partner at Hardwick & Morris, believes the government should consider taking the opportunity to make a major change such as replacing IHT with CGT.

While he is “fully aware this would create some problems”, he believes a government wishing to look seriously at simplification should explore combining the two taxes into one capital tax. “It would also eliminate some of the issues that currently arise when the two taxes interact,” he says. 

Business reliefs 

The OTS says the government should consider whether it is still appropriate for the qualifying level of trading activity for business property relief (BPR) to be set at a lower level than that for the CGT gifts holdover relief or entrepreneurs’ relief; review treatment of indirect non-controlling holdings in trading companies; and consider whether to align IHT treatment of furnished holiday lets with that of income tax and CGT, where they are deemed trading if certain conditions are met. 

Dawn Joughin, specialist private client lawyer at Excello Law, would welcome a review of the treatment of let property. “Furnished holiday lets are treated inconsistently between the taxes. For income tax and CGT, rental properties are treated as trading businesses. However, they do not qualify for BPR. Generally, properties are at the ‘thin end of the wedge’ when it comes to claiming both BPR and agricultural property relief,” she says.

Joughin notes that property holding companies – “companies that purely hold property” – are ineligible for BPR. “For other ‘trading companies’, in order to claim BPR for shares held in them when they own a property, it is necessary to show that the property is absolutely necessary to the running of the business.” 

Unprecedented interest

Philip Hammond asked the OTS in 2018 to review administrative and technical aspects of IHT. The OTS noted an unprecedented level of engagement in its review, with nearly 3,000 responses to an online survey and 100 formal responses to a call for evidence. It reported in November 2018 on administrative issues.

The OTS reports were laid before parliament as required under Finance Act 2016 and Sajid Javid, Hammond’s successor as chancellor of the Exchequer, will be obliged to respond. IHT practitioners will await his assessment with interest.

Andrew Goodall is a freelance tax writer and journalist